The Business Roundtable (United States), has recently revised its ‘Statement on the Purpose of a Corporation’ and walks away from the age old ‘shareholder primacy’ mantra. This new Statement re-positions the purpose of the corporation to include a focus on all stakeholders, rather than placing shareholders above all others. We believe this represents a significant symbolic turning point and will commence the process towards a new dissertation for the ‘Modern Corporation,’ apt for living in the post-industrial age. Our report revisits this age-old debate and provides insights for technology companies living in the 21st century.
/ The Business Roundtable (a US lobby group working on behalf of the largest US corporates), recently announced a symbolic shift from the shareholder primacy principle to an inclusive all stakeholder approach. We believe that this is not only a positive thing for society but will also promote better outcomes for shareholders of corporates, that will broaden their minds to include all stakeholders.
/ The inherent flaw with shareholder primacy is a) short termism and b) an excuse to profit at the expense of others. There is a myriad of historical examples (e.g. the Hayne review) in which there is a corporate focus on short term profits ahead of all other stakeholders, that creates instability and leads to sub optimal outcomes. In our view, a broader focus on all stakeholders will likely lead to longer, more viable business models.
/ The ‘Information Age,’ inequality and climate change bring complexity to unprecedented corporate decision making. Corporates need to ‘step up’ and take on a new form of responsibility over and above their responsibilities to shareholders. The shareholder primacy regime relies on a set of guard rails created by laws and regulators within which they are obliged to operate. Governments and regulators cannot hope to keep up with ever changing dynamics synonymous with the Information Age. The collective resources of corporates will continually belittle that of governments and regulators.
/ The world’s large technology companies have resources beyond most sovereigns and are developing business models that are overtaking society itself. Unless those who control our largest corporates are charged with making good decisions that benefit all stakeholders, we are doomed to failure. Artificial Intelligence (AI), machine learning, robotics and social media business models and outcomes have the ability to destabilise our democracies and societies. Attempting to regulate them is not a viable option. In the absence of effective regulation, the only alternate option would be to ‘shut them down.’ This refers to those that operate beyond what is acceptable – which we believe may ultimately be necessary in extreme situations. An example of this may be social media platforms being overrun, leading to riots and social unrest.
/ Corporates need to abandon reckless lobbying in the face of common sense and government need to shut down lobby groups. Lobbying can (and frequently does) lead to poor rules and regulations. Ineffective rules and regulations create the wrong price signals for investment. Poor investment leads to suboptimal societal outcomes, many of which have intergenerational outcomes, for example, inequality and climate change.
/ The concept that it is too difficult or confusing to make decisions, without knowing which stakeholder is ‘king’ is ludicrous and rooted in self-interest. We agree that good decision making can be challenging even when conditions are favourable, however, we also believe that our best corporations are typically run by well qualified people, who have the capabilities required for challenging their thinking and coming to the right decisions.
/ Whilst the Corporations Act could be improved upon (for example, like it has been in the UK), to broaden the duty of review to impacts on all stakeholders, the current version does not prohibit boards and CEOs from doing this already. All prior reviews of shareholder primacy have concluded that options exist to permit a broader review. We believe that it would be preferable to go further. However, given there is nothing in corporations law that prevents boards from reviewing the impacts of decisions on all stakeholders it is a matter of ‘best practice’. As such, we believe that Boards and CEOs (and all decision makers) should always reflect on all stakeholders in drawing their own conclusions in the decision making process.
The US appears to be shifting the model to a more inclusive model for all stakeholders, not just shareholders
On the 19th of August 2019, the Business Roundtable (a US lobby group), abandoned its former position on the role of the corporation, from one where shareholders and profits had prevalence, to an inclusive role, where all stakeholders are to be equally recognised.
This new ’Statement on Purpose of a Corporation’- which was signed by around 181 of the US’ leading businesses and funds - broadens the focus on:
Delivering value to customers;
Investing in employees;
Dealing fairly and ethically with suppliers;
Supporting communities; and
Generating long term value for shareholders.
Importantly, the statement represents an inclusive model:
“Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.”
Source: Business Roundtable, August 2019
Shareholder primacy is heavily lifted from Milton Friedman’s work on free market economics – but the circumstances are changing
The concept of shareholders primacy heavily modelled on Milton Friedman’s free market economics and theory, which details that if corporations focus on profits as their primary objective, this invariably leads to more favourable outcomes for society as whole. His only caveat to chasing profit (or shareholders wealth creation) is not to infringe on any laws.
"In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires...the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation...and his primary responsibility is to them…
…there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."
Source: Milton Friedman, 1970
We believe that times have changed and with these changes is the need to broaden the focus of our modern day corporations
There are many reasons why the primacy of shareholders regime has been challenged, and it is a requisite that our boards and CEOs adjust their thinking, visions / mission statements and factor in all stakeholders in business plans and activities.
The key issue resides in the ability for large corporates to outmanoeuvre under-resourced governments and regulators, which can lead to a set of rules that can be mistreated for profit. A few ‘traditional’ examples that impact employees, customers, suppliers, communities and the environment include the following:
Hydraulic fracturing or ‘fracking’ – which threatens water supplies.
Tax avoidance – where in particular large corporates can outmanoeuvre the laws and circumvent taxes that would otherwise intended.
Gambling and poker machines – which have resulted in problem gamblers and destroyed families.
The obesity epidemic – where fast food and beverage operators have excessively advertised their products to create unhealthy dispositions and addictions to food and beverages, that results in health adversity.
Excessive use of purchasing power – where large organisations can reduce price and terms of the purchase of their suppliers beyond what is reasonable. Xero recently found that 53% of large businesses typically pay SMBs late.
Plastic bottles and waste – large beverage companies selling beverages in plastic bottles clog public waterways. According to the Port Phillip EcoCentre environment group, approximately 800 million bits of rubbish are flowing into Port Phillip Bay annually from just two rivers.
We believe there are a range of contemporary that will arise.
Many people have sceptical opinions of the aforementioned ideas and believe that the Business Roundtable’s Statement is merely rhetoric. We would like to take a more positive view and reserve judgement and monitor the actions of these decision makers. We also believe it is a useful symbolic statement, and one that creates awareness for all corporates globally. Finally, it is our hope that the Statement will shift sentiment and promote debate.
The primacy of shareholders is already challenged and at risk of systemically leading to sub-optimal outcomes for societies and ultimately corporates themselves
We believe the shareholder primacy argument is challenged in contemporary society. In many cases, the interests of individual stakeholders is unquestionably symbiotic. For example, happy customers, happy employees, happy suppliers, happy communities are most likely to lead to positive outcomes for companies. However, this is not always the case. In many cases, particularly when considering shorter term outcomes, there are those who experience positive and those who experience negative outcomes that arise from any particular decision.
Consider the following:
Profits are simply a single measure of success for a corporation. In our view, the success of a business is better measured based on the value it delivers to all stakeholders in an inclusive way. Through the lens of the shareholder, we believe that long-term value creation will reflect the stewardship the company has on all its stakeholders.
The world has changed radically over the past 50 years, where the ’primacy’ of shareholders has been in favour. There are now estimated to be ~7.7 billion people in the world – compared to an approximate population of 3.0 billion in era of the 1960s, which has placed increasing pressure on scare resources and has resulted in increasing income inequality.
The world has entered the Information Age. Where once capital was ‘the key’ component, business now rely more heavily on all of their stakeholders to support their business model. Information is more transparent and accessible, and people have a greater ability and means to voice their concerns. This is namely possible through digital mediums, such as via the Internet and social media. Stakeholders cannot be ignored to the extent they could during the industrial revolution.
Levels of competition have shrivelled away. Most our larger industries (for example, banks grocery retailers, telecommunications, tech companies) operate with a few larger players that exert large market power. These market structure have come about through “creep” slowly gaining market share, and via M&A. In the case of the tech companies, their market power is practically global without real constraints from regulators (for example, as evidenced by the high quality media review recently undertaken – but the review will really not change anything anytime soon). Facebook recently paid a US$5 billion fine (larger than the market cap of any one of the ASX listed media companies) without a dent to its share price.
Investors are increasingly seeking to invest in companies that have ‘purpose’ and adhere to broader governance on social and environmental matters. Accessing capital for business models that are broadly anti-social or environmentally unfriendly is becoming increasingly difficult. Institutional investors and pension funds ultimately represent the interests of members, whose views are becoming progressively negative towards companies that exacerbate issues such as climate change and inequality.
Finally, a lack of coherency or the very existence of government policy (e.g. energy policy) creates adverse outcomes from society and wider society. The lack of laws and regulations can allow companies to make profit and avoid paying the price for the social or environmental harm that they create. Unless corporations learn to self-manage in the interest of society and the environment everybody suffers unnecessarily. To surmise, we believe that corporations need to compensate for the void that is left behind by Government in dealing with negative externalities such as the climate and income inequality.
Some will certainly argue you cannot have ‘more than one master’ and multiple objectives is too confusing or that a corporation simply can’t run without being profitable
We believe that good decision makers can and always have dealt with complexities and are capable of making balanced decisions across multiple standards.
There are a myriad of issues, both practical and legal; that can arise from possessing a series of objectives rather than one that solely ranks ahead of the others. For example, how do we judge the performance of our corporations across multiple criteria? Who should be entitled to vote for the directors that represent them (who in turn appoint management)? Also, how do we know communities and the environment are getting a fair deal? These are only a sample of considerations, with many more examples available that are specific to the company or situation.
We agree that this new regime can introduce additional layers of complexity in particular circumstances, but this only serves to highlight the reasons as to why we should do it in the first place. Life is full of trade-offs and it has never stopped decisions being made - for better or worse. This is what makes us human – weighing up the pros and cons across complex criteria and determining the best decision or, in some cases, the decision that will have the most minimal fallout. If all stakeholders are treated with due respect and decision makers are obliged to make decisions in this a manner, it will lead to better outcomes for all stakeholders.
In respect of a company not being able to survive without making a profit – this is a statement of fact as it ultimately goes broke. However, we believe if a company can only make a profit at the expense of other stakeholders, it either needs to change its business model or be defeated.
So, how are we going in Australia and New Zealand?
In Australia, we have somewhat of a mixed report when considering the process of making good decisions on behalf of all of our stakeholders.
It is clear that many Australian corporates have, and in some cases been happy to, live with the ambiguity of looking after multiple stakeholders even when conflict exists. Outspoken CEOs, such as Andrew Mackenzie of BHP, have embraced climate change as an authentic threat, whilst also considering other stakeholders including his shareholders. When questioned on climate change, Mr Mackenzie is reported to have said: “you can’t argue with a rock.” Being a geologist, it is probably that he has an informed view. In a recent speech he explains, “The planet will survive. Many species may not.” He announced at the same time a $400m Climate Investment Program.
“Over the next five years this program will scale up low carbon technologies critical to the decarbonisation of our operations. It will drive investment in nature-based solutions and encourage further collective action on scope three emissions. Commercial success of these investments will breed ambition and create more innovative partnerships to respond collectively to the climate challenge. We must take a product stewardship role for emissions across our value chain and commit to work with shippers, processors and users of our products to reduce scope three emissions.”
Source: Andrew Mackenzie, 23 July 2019
It is also clear that our fund managers are supporting responsible investments. According to Responsible Investment Australia Association Australia (RIAA);
In Australia RIAA’s annual Responsible Investment Benchmark Report 2019 found that just under half of all professionally managed investments in Australia are now invested as responsible investments. This report found the industry hitting new heights at $980 billion now managed as responsible investments, representing 55 per cent of all professionally managed assets in Australia, up from $866 billion in 2017 (growth of 13% year on year).
In New Zealand the responsible investment market is continuing its upward trajectory with associated assets under management growing 3% in 2018 to $188 billion. This represents 72% of total professionally managed AUM (TAUM), now sitting at $261 billion, and is a threefold increase on the $58 billion invested in responsible funds only five years ago.
Source: RIAA, August 2019
An even more ambiguous concept is the Government’s roll assisting corporations and investors as they transition into the Information Age, and one where climate change represents a huge threat to our future economy. After many attempts, the Federal Government has failed to put a price on carbon, or any similar scheme; that would allow corporations, backed by investors, to make informed investment decisions. So why is climate change policy so important? We believe there are two key reasons:
Investment certainty. Corporations in the energy sector need to make long-term investment decisions. In the absence of Government policy, it is imperative that they make an assessment of how climate change might be managed or regulated in the future. This creates significant investment uncertainty, which brings risks and, on balance, fewer investments or investments in the wrong things;
Negative externalities. Negative externalities occur when a corporation runs a business making a profit yet someone else or society bears the cost. Based on broadly accepted scientific research, the decision to endlessly burn fossil fuels by our major corporations has a cost to society and the world. Without a ‘price on carbon’ (which can be achieved in a variety ways), these companies and their shareholders profit at the expense of nations, including our own. This point is made without even beginning to address a wealth transfer from future generations to the current generation.
According to the Governance Institute, the shareholder primacy is not enshrined in law, and as such decision makers are free to make decisions following consideration of the merits to all stakeholders
In Australia, the Corporations Act 2001 (Cth) states, in s 181(1), that:
A director or other office of a corporation must exercise their powers and discharge their duties:
(a) in good faith in the best interests of the corporation; and
(b) for a proper purpose.
Whilst subtle, the legislation does not prohibit decisions being made more broadly than the shareholder primacy principle:
“It is important to clarify that the legislation does not state that directors and other officers must exercise their powers and discharge their duties in the best interests of shareholders, although case law has tended to grant primacy to shareholders’ interests. The legislation foregrounds the best interests of the corporation, which generally coincide with the best interests of shareholders.”
Source: Governance Institute of Australia, 2014 “Shareholder Primacy: Is there a need for change?”
There have been two enquiries conducted into the issue of shareholder primacy both in 2006:
Corporations and Markets Advisory Committee (CAMAC); and
Parliamentary Joint Committee on Corporations and Financial Services (PJC).
The conclusion of both enquiries was the law was adequate and did not require amendments, after considering the UK’s permissive laws requiring broader stakeholder review in circumstances.
Whereas we would perhaps prefer some additional obligations be placed Australia’s corporations, there is no motive as to why they cannot begin to conduct themselves in a method consistent with broader stakeholder management – which is being pushed heavily by shareholder groups.
In this light, the following terms were suggested by the Governance Institute of Australia (2014):
A director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to —
(a) the likely consequences of any decision in the long term
(b) the interests of the company’s employees
(c) the need to foster the company’s business relationships with suppliers, customers and others
(d) the impact of the company’s operations on the community and the environment
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly between the members of the company.
Source: Governance Institute of Australia, 2014 “Shareholder Primacy: Is there a need for change?”
We firmly believe that the time is approaching where all corporates need to review their raison d’étre with urgency. The 21st century is an unprecedentedly complex and Corporates exert more control over their environments than was the case in the last century. Inequality and climate change pose an emerging threat to our society and corporates (in addition to governments – making laws and regulations and redistributing wealth), are now forced into the fray given their immense powers – on a global scale. If corporates do not aim to create value for all stakeholders, boards and management may find themselves looking for new jobs or wear the wrath of their shareholders, employees, suppliers and customers.
Appendix 1: Charts
Figure 1. Responsible investment in AUM as a proportion of TAUM (Australia)
Source: RIAA, August 2019
Figure 2. Responsible investment in AUM as a Proportion of TAUM (New Zealand)